What is a 'Decision Tree'

A decision tree is a schematic, tree-shaped diagram used to determine a course of action or show a statistical probability. Each branch of the decision tree represents a possible decision, occurrence or reaction. The tree is structured to show how and why one choice may lead to the next, with the use of the branches indicating each option is mutually exclusive.

BREAKING DOWN 'Decision Tree'

A decision tree is a graphical depiction of a decision and every potential outcome of making that decision. It can range from something simple to a complex undertaking. Decision trees give people an effective and easy way to understand the potential options of a decision and its range of possible outcomes. This helps people identify every potential option and weigh each course of action against the risks and rewards each option can yield.

Depicting a Personal Decision Tree

All decision trees begin with a specific decision. This initial decision is depicted using a small square to the far left of the eventual tree. Lines are drawn outward from the box, representing each potential option. At the end of each line, or option, it is important to analyze the results. If the result of an option is a new decision, a box is drawn at the end of the line, and new lines are drawn out of that decision, representing the new options. If the result of an option is unclear, a circle is drawn at the end of the line, denoting a question mark and potential risk. If the option results in the solution to the decision, the line is left blank.

Each line moves from left to right, and a decision tree can span as long or as short as is needed to come to a proper conclusion. A person depicting a decision tree should include every possible decision, outcome and scenario in the tree. This helps with analysis and ensures there are few surprises.

Analyzing a Decision Tree

Ultimately, a decision tree is used to clarify and find an answer to a complex problem. The structure allows users to take a problem with multiple possible solutions and display it in a simple, easy-to-understand format that shows the relationship between different events or decisions. The furthest branches on the tree represent the end results.

Each end result should be assigned a risk and reward weight or number. A user analyzing a decision tree looks at each final outcome and assesses the benefits and drawbacks. The result with the highest total value is chosen and a decision is made.

  1. Decision Analysis - DA

    A systematic, quantitative and visual approach to addressing ...
  2. Christmas Tree

    An options trading strategy that is generally achieved by purchasing ...
  3. Christmas tree (oil and gas)

    A vertical assembly of mechanical elements used in oil exploration ...
  4. Decision Theory

    An interdisciplinary approach to determine how decisions are ...
  5. Financial Economics

    A branch of economics that analyzes the use and distribution ...
  6. Tree Diagram

    A diagram used in strategic decision making, valuation or probability ...
Related Articles
  1. Investing

    Using Decision Trees In Finance

    A decision tree provides a comprehensive framework to review the alternative scenarios and consequences a decision may lead to.
  2. Investing

    Using Decision Trees In Finance

    These decision-making tools play an integral role in corporate finance and economic forecasting.
  3. Trading

    Dollar Tree Forces Wal-Mart to Think High-End (DLTR, WMT)

    Wal-Mart shouldn't compete with its low-end competitor Dollar Tree. Instead, the company should compete with its higher margin competitors.
  4. Investing

    Dollar Tree Shaken By Strong Dollar, Shares Fall (DLTR)

    Tuesday's selloff will pass and Dollar Tree, thanks to its merger with Family Dollar, will survive this.
  5. Insights

    Dollar Tree Soars 9%, Nets 52-Week High on Q1 Beat (DLTR)

    Dollar Tree reported better than expected first quarter earnings that showed that consumers haven't stopped spending to the extent investors feared.
  6. Investing

    Moat: My Favorite Financial Term

    Kevin Carter, founder of Big Tree Capital, shares his favorite financial term.
  7. Investing

    Add Extra Appeal, and Market Value, To Your Yard

    Spring landscaping projects are worthwhile because, in addition to bringing more appeal to your yard, they'll increase the resale value of your home.
  8. Investing

    7 Tips to Cost-Effectively Landscape Your New Home

    Boost your new home's value and curb appeal with smart and cost-effective landscaping tips.
  9. Trading

    Does Your Personality Match Your Trading Methods?

    Investing has ways to successfully accommodate a variety of personalities. Learn how to align your trading with your traits.
  10. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
  1. Does homeowners insurance cover tree damage?

    Discover how damage to a home from fallen trees is covered under your homeowners insurance policy if it happens suddenly ... Read Answer >>
  2. How does seasonality affect the forest products sector?

    Find out why the concept of seasonality is critical to understanding the forest products sector for both producers and consumers ... Read Answer >>
  3. Who are Family Dollar's (FDO) main competitors?

    Learn about the discount retail company Family Dollar and its main competitors. Explore how competitor Dollar Tree plans ... Read Answer >>
  4. How do you determine the Critical Path in operations management?

    Find out how to develop and use the critical path in a standard critical path analysis, a popular operations management technique ... Read Answer >>
  5. What is the difference between macroeconomics and finance?

    Dive into the world of economics by learning the key differences between macroeconomics and finance. These ideas help investors ... Read Answer >>
Hot Definitions
  1. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  2. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  3. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  4. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  5. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  6. Four Percent Rule

    A rule of thumb used to determine the amount of funds to withdraw from a retirement account each year. The four percent rule ...
Trading Center